Valuation and P/E's

[hendi_alex]

Everyone surely knows my position now. It runs against the grain of continuous accumulation, of cost averaging over a long investing horizon. I like a bargains way too much to be paying full value or to be overpaying for shares of target investments.

What concerns me mostly right now, is that the P/E ratios are essentially smoke and mirrors where almost the entire market is frothy and beyond. There may be value in the energy patch, but there again, even after the sell off, shares of many of those are still far ahead of where they were even prior to the 2008/2009 market collapse.

To my way of thinking, P/E's are misleading, as so much of the profits are a result of very cheap money. When the Fed moves toward some degree of normalization of interest rates, that aspect of inflated profits will begin to bleed off. Couple that with a contraction cycle, and we could have a double whammy on the current lofty level of corporate profits, which are at present about 70% or more above the mean. What will it do to share prices if corporate profits simply drift back to the mean, or worse if recession comes and they dip toward the low end of the range?

Those concerns are what keep a large portion of my portfolio in cash and/or in very short term investments. I would certainly rather buy my shares at a strong discount to inherent value, and absolutely insist on buying them at significantly below today's lofty levels.

[EricL]

(02-13-2015, 09:40 AM)hendi_alex Wrote: Everyone surely knows my position now. It runs against the grain of continuous accumulation, of cost averaging over a long investing horizon. I like a bargains way too much to be paying full value or to be overpaying for shares of target investments.

What concerns me mostly right now, is that the P/E ratios are essentially smoke and mirrors where almost the entire market is frothy and beyond. There may be value in the energy patch, but there again, even after the sell off, shares of many of those are still far ahead of where they were even prior to the 2008/2009 market collapse.

To my way of thinking, P/E's are misleading, as so much of the profits are a result of very cheap money. When the Fed moves toward some degree of normalization of interest rates, that aspect of inflated profits will begin to bleed off. Couple that with a contraction cycle, and we could have a double whammy on the current lofty level of corporate profits, which are at present about 70% or more above the mean. What will it do to share prices if corporate profits simply drift back to the mean, or worse if recession comes and they dip toward the low end of the range?

Those concerns are what keep a large portion of my portfolio in cash and/or in very short term investments. I would certainly rather buy my shares at a strong discount to inherent value, and absolutely insist on buying them at significantly below today's lofty levels.

You bring up some good points. I think the cheap money phenomenon is a reminder to invest in quality companies with strong balance sheets. When/if the era of cheap debt passes away, the highly levered companies will take the biggest hit and give the stronger players an opportunity to pick up market share.

Growth is nice, but strength and stability is better.

[DividendGarden]

(02-13-2015, 09:54 AM)EricL Wrote: When/if the era of cheap debt passes away, the highly levered companies will take the biggest hit and give the stronger players an opportunity to pick up market share.

I completely agree with this. I know that a lot of companies are taking advantage of low rates right now, which is the right thing to do for their shareholders. Going forward, if rates rise, it will be interesting to see who can manage their debt levels. As for me, I'm sticking with companies that have responsible balance sheets who have been around for a long time.

[crimsonghost747]

One thing is for sure, the FED won't do anything stupid. Everyone is talking about the rising interest rates etc. but I'm as sure as I can be that when the FED makes their move, it's going to be a tiny one. Meaning the impact on both interest rates and company profits due to cheap money will be very minor. Noticeable, but nothing to be worried about. Then later on, provided they think the economy can handle it, they will continue to bring the interest rates to where they think they should be.

I would be very surprised to see a big decrease in company earnings that resulted from the FED's actions. I still maintain a decent cash position, mainly because I think the current P/E levels are simply too high for a lot of the good companies. If a bigger downward correction comes I think it's more to do with the general economy as well as the inflated share prices rather than the FED.

[benjamen]

hendi_alex's thoughts give rise to a few questions for me:

1) What sectors/types of companies do well (or just less affected) in an economic contraction?
http://www.investopedia.com/articles/sto...ession.asp
Discount stores, tobacco and alcohol, healthcare and utilities?

2) What sectors/types of companies do well (or just less affected) in an environment of rising interest rates?
http://dividendgrowthforum.com/showthread.php?tid=852
Banks and insurance companies?

3) When everything appears over valued, why not build up a cash reserve to take advantage of future better deals? As a percentage of your total portfolio, what is your personal max for cash on hand?

[ChadR]

benjamen,

I keep little to no cash on hand in my account. Since I've been investing (2000), I've always found at least one stock that was fairly valued to undervalued. I'm horrible at timing the markets. If I waited for better values, I'd be constantly sitting on cash since, "Hey, it can go lower and I can get that much more of it." I'd rather get my cash invested ASAP and collect my dividends than use my horrible market timing.

[EricL]

(02-17-2015, 09:05 AM)ChadR Wrote: benjamen,

I keep little to no cash on hand in my account. Since I've been investing (2000), I've always found at least one stock that was fairly valued to undervalued. I'm horrible at timing the markets. If I waited for better values, I'd be constantly sitting on cash since, "Hey, it can go lower and I can get that much more of it." I'd rather get my cash invested ASAP and collect my dividends than use my horrible market timing.

Same thoughts here. I never have a problem finding a place to invest new money.

[hendi_alex]

I'm currently at 20% cash and if all of my 'in the money' short calls get exercised between now June, another 25% could hit the pot. Not much chance of staying way overweight cash for long though, as transient opportunities turn up pretty regularly. It is much easier to find that kind of opportunity in this toppy market than it is to find deep value in typical DG fodder.

I generally like to keep at least $40k-$50k on hand as opportunity cash. I'm not much of a believer in the efficiency of markets in pricing. Any time any headline hits, the market tends to over react going in one direction or another. The most recent deployment of opportunity cash was in energy during mid December. Most of those plays generated about 15% in a couple of weeks. For the most part those gains are banked and the investing dollars have been moved back to cash, waiting for the next opportunity. A good bit of our cash was also invested in longer term positions of energy stocks during the December sell off.